PERSONAL FINANCE

When we think of inter-generational wealth, we often think of trusts and the proverbial trust-fund babies.

While a trust can be a great way to house inter-generational wealth, over the last 10 years there have been significant changes to the laws that affect the way trusts are administered and taxed.

This has made the administration of the trusts more onerous, expensive and less tax efficient. However, there is still a place for the trusts, as long as it is used for the correct purposes.

According to Tanya Lochner, fiduciary expert at Gradidge Mahura Investments, there are three main reasons for using a trust:

• Protection: A trust can be used to protect assets. This could include the case of someone with special needs such as dementia, or a drug addict. It can also be used to protect assets from the creditors, including divorce claims.
• Wealth generation: A trust can house assets for future generations without transferring ownership and the consequential tax implications.
• Tax benefit: While the tax benefits of trusts have been reduced, a trust can save on death costs. However, there may be other tax implications you need to be aware of.

Lochner says when it comes to setting up a trust, you need to consider what assets are appropriate.

These should be long-term growth assets such as property, investments and even life insurance polices.

But a short-term depreciating asset such as a car would not be an appropriate item to include.

TWO WAYS TO SET UP A TRUST

• Inter vivos trust: This is a trust created during your lifetime and assets can be transferred into the trust.

This is usually done via a loan account or donation.

• Testamentary trust: This trust is stipulated in your will and only comes into effect on your death.

At this point, the assets would be transferred into the trust. This is mostly used by parents with minor children.

Lochner says a testamentary trust is for shorter-term needs and would not typically be used where there are longer-term goals such as inter-generational wealth creation.

The trust terms and conditions are included in the will and cannot be changed once the founder dies.

However, an inter vivos trust is a “living trust”. And the trust deed can be altered when appropriate, such as when the tax laws change, provided the trust deed makes provision for it.

DISADVANTAGES OF TRUSTS

Once you transfer assets into a trust you lose ownership and, largely, control over that asset, explains Mariska Redelinghuys, a legal specialist at PSG Wealth.

Redelinghuys says:

She explains that the Master of the High Court now requires that, if all the trustees are related to each other, an independent trustee be appointed.

This must be someone who is not related and understands the job and responsibilities of a trustee and can assist the family on discharging duties.

Due to increased regulation, trusts have become more expensive to administer. This is because the trustees carry the risk and responsibility of the assets they administer on behalf of the trust.

For example, Redelinghuys says that, under the Trust Property Control Act, failure to maintain a register of beneficial ownership could result in a fine of up to R10 million or imprisonment for a maximum of five years. Another important factor to consider is how the assets are transferred to the trust.

As Lochner explains, you cannot just transfer assets into a trust, this would have to be done as a donation or sold to the trust resulting in a loan account.

A donation of more than R100 000 per annum per individual would attract a donation tax of 20%.

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In the case of a loan account, where the trust is required to pay for the assets, section 7c of the Income Tax Act requires market-related interest rates to be charged on loan accounts, treating foregone interest as a deemed donation.

However, you could bequeath the assets to the trust on your death. That removes the need for a loan account and there would also be no transfer duty in the case of fixed property.

The first R3.5 million of your estate can be bequeathed to a trust without paying estate duty.

All these factors must be discussed with a tax expert so that you fully understand the implications.

There are also administration costs that need to be considered.

While the trust fees are not regulated, most fiduciary companies will charge about 1.5% of the value of the assets to manage the trust and a further 6% on the income.

However, there is usually a fixed fee. This can range from R10 000 to R18 000 a year, depending on the complexity and the risks associated with the trust.

While one could negotiate the fees on the less complex trusts, for the estates worth less than R1 million, a single trust may not be viable.

COST-EFFECTIVE TRUSTS

Beneficiary funds and umbrella trusts can provide cost-effective protection for both minor children or elderly parents who may be unable to manage their finances.

As David Hurford, of Fairheads Benefit Services explains, unlike other trusts where a trust deed needs to be set up for each child, an umbrella trust can save you money.

This is because the fund usually sets up one trust deed for all the fund’s beneficiaries. Individual trust accounts are, however, opened for each child. The trustees would work with the guardian and the child to ensure that expenses are covered.

They would normally pay the school fees directly and provide a level of income for the guardian to feed and clothe the child.

A good trustee would ensure that the funds were used for the care of the child. And, where possible, a lump sum may still be available when the child turns 18.

The trustees would provide the child with financial education to ensure that, when any funds become due, the child is able to better manage the money.

Hurford says:

He says that, unlike single trusts, there is no fixed fee and they charge between 1.5% to 2% of the assets under administration.

For example, on an estate of R300 000, the fee would be between R4 500 to R6 000 a year. A beneficiary fund is linked to your employer benefits.

This can house the proceeds of your retirement fund and group life cover. If you are a single parent or are concerned about protecting your child’s assets, you could nominate a beneficiary fund to be used for the child’s portion of your retirement fund.

You could also select a beneficiary fund as the recipient of the group life cover. For assets or life cover outside your company benefits, an umbrella trust could be used.